Close, But No Cigar

Having taken a look at Colin Lambert’s predictions for 2018, Galen Stops finds that he was almost right with all of them. “Almost” being the operative word.…..

1.“Bitcoin. That’s The Thing That Goes Up, Right?” – “The advent of futures in Bitcoin will take volatility out of the market. The cryptocurrency will end the year lower, not at zero, but in the single digits of thousands of dollars.”

Colin definitely scored a hit with his price prediction, with bitcoin currently at $3,500 at the time of writing. However, he did give himself a rather generous amount of leeway by effectively predicting that it would end the year anywhere between $1 and $9,999. Meanwhile, I think it’s safe to say that his prediction that the launch of futures would reduce volatility in this market was well wide of the mark, given that in January the price dropped from $15,300 down to $7,600 in February, back up to $11,500 in March, down to $6,900 in April, back up to $9,300 in May, etc, etc – you get the point.

Now to give Colin (grudging) credit, he did say that if bitcoin continued to be predominantly traded on OTC platforms at varying price levels then “the emotional rollercoaster that was bitcoin in 2017 will continue apace”. There’s a number of reasons why the market structure shift that Colin predicted towards more futures trading didn’t occur. Institutional money has been slower than many anticipated to actually start trading in the crypto space – this is largely due to a lack of institutional grade infrastructure (eg. custody services) and a lack of diversified investment products available (eg. crypto indices). Although more professional trading firms are now active in the space, it is still a largely retail-driven market and with the exchanges requiring 100% margin to trade bitcoin futures, it’s unlikely that any retail punters will be demanding access to those products any time soon.

Rating: 6/10

2.“Not Necessarily Consolidation But…” – “CME’s FX Link will be a big play of 2018 and how it works could dictate the M&A landscape in FX. A successful FX Link could provide the circumstances for CME to buy an OTC platform, specifically NEX Group.”

Much as it pains me to say it, I have to give credit where credit is due, and Colin was bang on the money here. As we all know, CME did indeed buy NEX Group last year, while Deutsche Boerse also added to its FX portfolio with the acquisition of the GTX platform. “The key to the identity of potential buyers will be, probably, the ambitions of their clearing business, because this could help drive revenues” wrote Colin last year, and yes, both of the aforementioned exchange groups operate sizable clearing houses.

However, I can still get him on a technicality here. P&L’s very own Nostradamus said that it was unlikely that one OTC platform would buy another one, and if you go back and look at the actual wording on the press release it says that Deutsche Boerse’s “360T unit has agreed to acquire the GTX ECN business from Gain Capital for $100 million” – thereby meaning that one OTC platform did buy another one. Yes, I’m being pedantic, and yes, I’m clutching at straws slightly to mark Colin down for this prediction.

I feel like it’s also worth pointing out that platform consolidation is a perennial favourite prediction for Colin – in the 2017 P&L Crystal Ball he predicted a possible NEX Group sale to either CME, ICE or Nasdaq. As such, the saying about even a broken clock being right twice a day does come to mind. Nonetheless, the timing was fortuitous for him this year.

Rating: 9/10

3.“The Great Divide” – “2018 will be all about the data and it will empower those willing to pay for it, however there will be challenges for those who cannot or will not pay up to consume and store the vast amounts of data required. Those with data will be more protective of how their pricing is used by counterparts and those without will struggle in an increasingly fragmented market as more platforms package and sell their data.”

This is a tricky one to assess, given that there’s not exactly readily available data regarding how many people are paying how much for data, while analysing the impact of data is rather subjective. Certainly, Colin was correct in saying that in 2018 the focus on data would only grow more intense, but I’m loathe to give him a good score for simply pointing out the obvious.

He made an interesting point in the original article, talking about how in the year ahead we would see data divide the market into “haves” and “have nots”, but the reality is that this is only true in certain areas. Certainly, in terms of accessing market data feeds this is the case, but in the case of data analytics around trading it seems to me that although, yes, the top players will have more to invest in this area, increasingly less sophisticated market participants are getting better tools (that satisfy their frankly less sophisticated needs) at lower and lower price points. In this area, you could make the case that data is proving to be a democratising force.

As an interesting aside here, I did speak to a number of FX hedge funds that are using artificial intelligence (AI) to trade the markets and – rather than accessing and storing data – they all cited the scarcity of human expertise in handling, analysing and effectively deploying the necessary data as their biggest challenge. And so the irony of the increasingly data-driven market is that the real have/have not divide could actually be between the firms that can find and attract the top human talent.

Colin does better in arguing that those with data will do more to prevent their prices being recycled, “market impact” was definitely one of the most oft repeated phrases at Profit & Loss conferences last year and clearly a lot more thought is going in to what happens post-execution in FX trading.

Overall, I think that Colin raised a very interesting point about how data is changing both the financial market in general and FX trading in particular, and I think there’s a very interesting debate to be had about whether data will prove to be a democratising force or something that reinforces the position of the incumbents. But I think that one way or another this is a trend that will play out over a longer time horizon than one year.

Rating: 7/10

4.“Going Greener” – “There will be more focus on liquidity re-cyclers and some may be squeezed by the ‘tier 1 LPs’ they all boast of. This means we could end 2018 with a smaller, but stronger group of liquidity providers that are held to a higher standard than previously.”

Ok, so there’s really no way to nonsubjectively rate this one, which means that I’m just going to go ahead and try to give Colin a low score and then work backwards to justify it. This is trickier than it sounds, because as I read back the original article I see that he hits the mark with a number of his points. For example, Colin notes that liquidity providers are growing more sensitive to how their pricing is used, while customers are more conscious of how their flow is handled, a combination that he said “is likely to lead to significant pressure on those firms whose business models are predicated on recycling liquidity”. So far, so good for Mr. Lambert here.

But then comes the inevitable fumble. “It is hard to know exactly how the industry will deal with the issue of liquidity recycling….but something is likely to be done,” says Colin in the piece. That right there, ladies and gentlemen, is almost 40 years of FX experience and insight being distilled into that part of the “prediction”. Enjoy.

Continuing on through the original article Colin says that the FX Global Code could be another driver for this “something” that is likely to be done, arguing that it might encourage “quote and cover” providers to explicitly disclose their models. This, plus the growing pressure from the liquidity providers providing the original price and the customers themselves, claimed Colin, “will inevitably challenge the business model” for liquidity recyclers. The end result, he argued, would be that 2018 could end with fewer liquidity providers that keep higher standards.

My view on this? Meh. Colin might be right that the squeeze is on for firms recycling liquidity, but I’m not aware of any significant liquidity providers exiting the FX space in the past year, and indeed it seems like there are more firms making the case that there’s room for additional LPs in the market. I do think that the dialogue between liquidity providers and consumers has improved and become more sophisticated, however, but whether that changes the quality of the LPs themselves is debatable.

Rating: 7/10

5.“Can Peer Pressure Work?” – “The biggest challenge for the FX Global Code will be getting peripheral players onboard. The GFXC will need more examples and clearer guidance over who is responsible for ensuring anonymous environments operate fairly. Three key words for the GFXC will be “marketing”, “education” and “evolution”.”

In this prediction Colin said there was likely to be a “show of force in 2018” from firms that had signed the Statement of Commitment who demand that their adherence to the Code is matched by all the participants on a particular venue, even when trading anonymously. Looking at this part of the prediction a year on, and I think that perhaps Colin was a little optimistic about how much firms that do sign the Code would be able (or willing) to twist the arms of those that haven’t. Given a longer time-frame and this prediction could, possibly, perhaps, bear fruit, but in my conversations with market participants they’ve made it clear that they’re giving their counterparties and service providers a fair amount of leeway in terms of timeframe for committing to the Code.

For example, one source at a large buy side firm says that they are reluctant to draw lines in the sand for counterparties on this issue because their own due diligence and legal work took a long time to complete and so they are sympathetic to other firms going through the process. They also say that they are still educating both their bank counterparties and service providers on what their stance and approach is to the Code and so it would be harsh to start trying to penalise them for not adhering.

Colin anticipated that as a result of this show of force there would be a bifurcation of liquidity into a “clean” pool where everyone has publicly adhered to the Code, and a pool where, as he put it, there is a “free-for-all”. Again, to the best of my knowledge, this hasn’t really occurred in a widespread way amongst the industry.

Where he’s on safer ground is in stating that the greatest challenge for the Global FX Committee (GFXC) will be getting firms on the periphery of the FX market – by which I take it to mean firms for which FX trading is not central to their business but more of a necessary function – onboard. Thus far, the banks and trading platforms have been the quickest to adopt and embrace the Code, while only a handful of (largely FX-focused) asset managers have done so. Proponents of the Code have been transparent about their frustration that the buy side has been slow moving on this, despite the active participation of many of these firms during the creation of the Code.

Part of the reason why this has occurred is that the individual representatives from those firms were the people responsible for managing the firm’s currency trading, and thus they were keen to participate in the discussions about the Code. However, FX trading is often not a priority within their larger organisation and when there are larger compliance concerns than something that is not regulation and not as impactful for the firm as, say, MiFID II, then it’s not surprising that there hasn’t been any great rush to adopt the Code.

I also think Colin was right with his prediction about “marketing”, “education” and “evolution” being key words for the GFXC, and these are themes that I heard committee members talk about more than once at events in 2018.